Market Design for Increasing Variable Resource Integration

Renewable resources that are variable will continue being deployed on the bulk power system and in wholesale markets. Between existing financial incentives (aka subsidies), enormous technological advances, cost reductions, state mandates, and consumer demand for lower or zero emitting resources, variable resources in the form of wind and solar are here to stay and will only become larger and larger players in wholesale power markets.

Wholesale power markets will need to continue their evolution to accommodate variable renewable resources to ensure bulk power system reliability both in short term operations and long-term resource adequacy at the lowest possible cost. It would be easy to think that “reliability mandates” or “command and control” mechanisms can be developed to ensure renewable energy integration. But such mechanisms would only increase costs in wholesale markets and undo all the powerful incentives for efficient and low-cost supply that wholesale power markets have developed over the past two decades. What we need is better market design that harnesses the power of economic incentives to ensure reliability at least-cost and enhances the competitiveness of the existing wholesale power market paradigm.

Harmonize Retail Rates with Wholesale Market/Bulk Power System Conditions

In wholesale power markets, prices change every 5 minutes and conditions can change sharply over a period of minutes to an hour. Prices when high, are signaling a reliability need for more generation or less demand. When prices are low, more demand or less generation. But most of the load is served under retail rates that do not vary by time or system condition. And some, like in California, may even have inclining blocks where the price increase as the consumer uses more during a billing period.

The problem with the “duck curve” (or insert any animal you like) in California is that consumers do not see the low wholesale price in the middle of the day and cannot increase their consumption accordingly, nor do they see high prices when the solar and wind come off the system and could provide relief by consuming less during those periods.

Without this kind of harmonization, all the good market design in the world at the wholesale level would likely not solve the problems that would still exist due to the fundamental disconnect between retail rates and wholesale market conditions.

Operating Reserve Demand Curve

All US wholesale markets have some form of an operating reserve demand curve construct in place. The purpose of the operating reserve demand curve is to increase prices as the system gets close to eating into reserves to maintain energy balance, and these higher prices provide a signal of a deteriorating reliability position of the bulk power system. As increasing amounts of reserves are converted to energy to maintain energy balance, prices rise providing incentives for load to reduce consumption and for any additional supplies to come into the market, be it through imports or through generation resources operating into their emergency ranges to provide additional power.

But what I have in mind here is the kind of operating reserve demand curve that has been implemented in ERCOT, where price starts to rise prior to tapping reserves for energy and gradually increases, rather than in large steps that exist in other markets and increase to the value of lost load which can be thousands of dollars per MWh. Such an operating reserve demand curve indicates when the bulk power system is getting close to using reserves to satisfy energy balance and provides a signal as to how far into reserves the system is getting, which provides the opportunity for demand to reduce when the price reaches demand’s willingness to pay for energy before reducing consumption. The price rising as high as $9000/MWh, as it does in Texas, ensures that all likely price responsive demand can reduce before resorting to involuntary load shedding to maintain reliability.

Market-based Resource Adequacy Construct

All power systems plan to hold a certain amount of reserves to serve the forecasted peak load while accounting for generator outages, load forecast error, and extreme weather events (hot or cold). In a market environment, generation resources will not remain in commercial operation unless they can at least cover their going forward costs. These are costs that the generator owner must cover (e.g. fixed O&M, incremental investments, fixed overhead costs such as labor, taxes, and insurance) in order to stay in operation, otherwise it is lower cost to shut down and exit the market.

Generation resources can cover these going forward costs through energy market rents (the difference between the market price and their running cost) and through other revenue streams such as capacity markets. But with increasing penetration of renewables, energy market prices will be lower in many hours, if not close to zero, as the penetration of renewables increases. This means that generation required for resource adequacy will need to cover their remaining going forward costs through a capacity market. And a market approach will incentivize those resources with the lowest going forward costs, such as combined cycle and simple cycle gas resources.

Bigger is Better

Yes, size does matter…the size of the market, that is. The larger the market in terms of load served, geographic footprint and diversity, and resource diversity, the easier it is to manage power system operation in real time. This is the primary driver behind the western Energy Imbalance Market (EIM) where the geographic diversity in loads, renewable resources, and controllable fossil and hydro resources can all be brought together to smooth out fluctuations in variable resource output. PJM a few years ago commissioned a study that showed a large penetration of renewables (30%), albeit dispersed throughout the footprint, only creates minor operational problems.

Overall, with the four enumerated market design recommendations (well, three design and one scale and scope), there is no reason that further penetration of renewable resources cannot be achieved while ensuring the competitiveness of wholesale markets and bulk power system reliability at the lowest possible cost.

 

Paul M. Sotkiewicz, Ph.D. is the President and Founder of E-Cubed Policy Associates, LLC in Gainesville, Florida. Previously, he was the Chief Economist at the PJM Interconnection, Director of Energy Studies at the Public Utility Research Center, University of Florida, and a staff economist at the Federal Energy Regulatory Commission. He can be reached at drpaulg8r@gmail.com.